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The interest-rate debate
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BankWest Gold Coast area manager Peter Child gives a near-term outlook
THE belief among economists is that the next interest rate movement will be upwards - yes, an interest rate increase!
The new Governor of the RBA probably already has his finger on the trigger of another increase before Christmas - and the safety catch is more than likely not on either.
The best test to see the impact of an interest rate rise is to review your own cash flow situation. You need to ask yourself whether your business could support a 50 point (0.5 per cent) rate increase? What impact would that have on the bottom line? Would changes need to be made if interest rates did increase?
If the answers to these types of questions concern you, now is the time to talk to your banker. Should the RBA announce an interest rate increase, it is almost certain that the fixed rate products have already had the rate increase factored in.
The decision to fix or float your interest rate on your loan is as difficult as selecting the right property or business to purchase. The interest rate debate poses so much uncertainty. What happens if you elect to stay on a variable rate and interest rates increase? What happens if you fix the rate and wish to make additional payments or sell the asset?
To make an informed decision based on your own circumstances it's important to first understand the options available to you:
Variable interest rates
- Without doubt the most popular of interest rate options. While on a variable rate, most loans do enable the borrower to make additional repayments. Similarly, you can repay the entire debt without the prospects of large prepayments expenses. It is the loan account with flexibility. The risk however, is when interest rates increase. In a rising interest rate market, this can increase your expenses and consequently, reduce your surplus (profit).
Fixed interest rates
- After many years of being 'dormant', these types of loan products have increased in popularity during 2005 and 2006. The beauty of fixed interest rates is you know, from month to month, that your loan repayment will remain exactly the same and will do for the life of the fixed-rate period. This provides borrowers with certainty, as generally, the three biggest expenses to a business are wages, cost of goods and interest. The risk is that if you wish to sell the related asset, there could be a large prepayment expense.
- A popular drink and becoming an equally popular interest rate option. Borrowers select a mix of variable rate and fixed rate in an attempt 'to get the best of both worlds'. Flexibility can be obtained by having some variable interest rate, while protection from increasing interest rates is achieved by fixing a component of your loan.
In business and commercial borrowings, some financiers offer a number of other interest rate risk options - caps, collars and swaps to name a few. It is always best to speak to a financial market specialist and your local business banker, who will be able to provide this assistance.